Extract 1 – Finance Director’s Report
Possible reasons for Aaron Furniture Ltd making a loss in 2015
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An increase in interest rates. Interest on loans is a cost to the business.
Therefore, if banks increase the rate of interest businesses have to pay
more for the money they have borrowed. The case study suggests that
their yearly interest cost is only £10,000 so although this has had an
impact it’s doubtful it’s the sole reason
A fall in selling price. Over the last five years (2010 – 2015) the selling
price of a piece of furniture has fallen by £100 or 16.7% (100/600 x
100). This could be down to more competition or firms being able to
manufacture furniture cheaper so they are passing the cost reduction on
to the customer in order to gain more of the market.
High manufacturing costs. As previously mentioned, Aaron Furniture
produce some of their product lines made to measure. This would employ
job production which is time-consuming, labour intensive and costly. This
would only be worthwhile if they can sell their bespoke orders at a much
higher price. However, given the fall in selling price it appears that their
bespoke ranges are adding to very high production costs.
Analysis of the financial data given in Fig. 1. – Profit and loss for imported
and UK produced furniture. Egerton Wardrobe range.
A
B
C
D
B÷A
C÷A
Pieces sold
Revenue
Total cost
Profit
Selling price per wardrobe
Total cost per wardrobe
Profit per wardrobe
profit margin per wardrobe
= (profit/selling price) x 100
Imported wardrobes
1000
£
500,000
£
450,000
£
50,000
£
500
£
450
£
50
£
£
£
£
£
-£
UK produced
600
300,000
312,000
12,000
500
520
20
10%
-4%
Level 2 - Arguments for keeping some production in the UK
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Some customers might like the ‘Made in Britain’ product range.
Therefore, if Aaron Furniture remove this ‘seal’ from their product it
might mean that some retailers choose a different furniture supplier.
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Normally, ‘made in Britain’ can allow for a higher selling price. This is
because customers are more willing to pay more for products that are
directly supporting our economy. In addition, products produced in the
UK are often perceived to be high quality so customers may pay more
for them. However, given the selling price is £500 irrespective of
where it is produced this is not the case for these product lines.
As Aaron Furniture has been operating since 1980, with a factory
opened in 1984, they may have some highly skilled and long-serving
staff that they will have to make redundant. This might will cause
Philip ethical issues as well as public relations as firms making a lot of
people redundant will receive negative publicity which could reduce
demand for their products.
Made in Britain is a brand that will help Aaron Furniture Ltd compete
against other foreign firms (especially EU firms) that import into the
UK and can quite often offer cheaper prices that UK based
manufacturers.
Level 2 – Arguments for importing all of their products
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Cheaper costs. Closing the factory will lower their costs as they will have
to make redundancies. This will mean that they will not have to pay for
rent, bills, wages and any other costs associated with the factory.
Sweden is in the EU. This means that there will not be any additional cost
involved with importing products into the UK, helping to keep costs low.
However, this depends on whether the UK remain in the EU.
The cost of manufacture is cheaper. Each wardrobe is £70 cheaper to
manufacture in Sweden, this allows a profit margin of 10% per wardrobe.
In the UK, costs per wardrobe are £520 per wardrobe, £20 more than
the selling price which results in a loss for the product line.
Capacity issues in the UK limit the amount of goods that can be produced
in the UK factory, this could mean that Aaron Furniture are unable to
meet sudden increases in demand.
Falling price of timber. The case study suggests that the cost of timber,
the raw material used to make furniture, is falling. If this is in Sweden
then it could further reduce costs making the imported products more
profitable. If the falling cost of timber is in the UK then it might be a
reason for keeping the factory open.
Level 2- how the exchange rate impacts on the decision
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The rate of exchange between the GBP (Great British Pound) and the
Swedish Krona is an important factor. If the pound strengthens against
the Krona then importing will be cheaper. This would reduce the cost of
importing, making the profitability on imported products higher. However,
exchange rates fluctuate – there is no guarantee the pound will remain
strong.
Level 3 – giving a judgment
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Using the data provided in Fig. 1 closing the Bowton factory would seem
like the most profitable decision, especially given the whole company
made a loss last year. However, this is only the data on one product line.
The decision must depend on the profitability of the Belmont and
Ladybridge product lines as well. If they are not making a loss then it
might be best to only import Egerton and keep the UK factory for the
Belmont and Ladybridge in the short term. If selling prices continue to
fall then, in the long term, it might be cost-efficient to import all of
their product lines but this decision will depend on whether the Swedish
supplier have the expertise to manufacture all three product lines.
NOTE: In order to be fully prepared for the exam. Make sure you understand
all of the data given in Fig 1. They may give you similar information in the exam
for the Ladybridge and Belmont product lines.
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Extract 2 – Proposed changes to production
Issues with their current production method.
Level 1 – Bespoke or Job produced
Last year, Aaron Furniture made 22 different sizes of wardrobe and 16
different sizes of beside cabinet. They are proposing to change their
production method to only produce two different sizes. This would effectively
mean a move from job production to batch production.
Understanding methods of production.
Level 1 – methods of production
Batch
Mass/Flow
Batch production is when This is where identical
a business produces a
products are mass
batch of similar, but
produced, this is the most
different, products at
cost-efficient method but
the same time. The batch is only really suitable for
is then moved on to the
mass market products
next stage of the
where demand is very easy
production process.
to predict and the products
are the same.
Job
This is where each product is
made individually, most
commonly used when each
individual product is different
such as a construction. Normally
has much higher selling prices
but can only manufacture small
quantities.
Level 2 – Advantages of using job production for Aaron Furniture Ltd
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Job production allows them to custom make furniture to meet the needs
of an individual customer. This allows Aaron Furniture to gain a
competitive advantage over firms who do not offer this service. This can
allow Aaron Furniture to gain a reputation in the bespoke furniture
market.
Although more time consuming and expensive, job produced items can
warrant a much higher selling price than mass produced items allowing for
higher profit margins per product. However, the case study suggests that
selling prices are falling. Higher costs and lower prices = lower profit, or
in last year’s case, making a loss.
Level 2 – Disadvantages of using job production for Aaron Furniture Ltd
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Making to order can mean very high production costs. This is because of
the labour involved in making each order. This can lead to higher selling
prices (as previously mentioned) or much lower profit margins if they’re
unable to charge higher prices.
Job production is very time-consuming. This creates an opportunity cost.
For example, in the same time it takes to make one made to measure
wardrobe, they could have made ten if they employed a different method
of production, such as batch. This could be the reason they have capacity
(the total quantity they can produce) issues in the Bowton factory.
Level 2 – switching production to batch – advantages to Aaron Furniture.
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Batch production is more flexible, allowing Aaron Furniture Ltd to switch between
different product lines and styles of furniture.
o This allows them to produce a greater quantity of a variety of products and
potentially increase their capacity. This will reduce the cost of each item of
furniture.
o Reducing the cost of manufacture allowing Aaron Furniture Ltd to improve
the profit margins per item of furniture.
o They will still be able to meet the needs of different customers, but might
lose the customers that only buy from them for their bespoke services.
o Using batch production might mean less staff are needed (as they are not
individually crafting each piece of furniture) meaning lower wage costs.
o If furniture is the same size (or only two sizes) ordering raw materials
becomes easier. This could result in ordering timber in bulk and benefitting
from a purchasing economy of scale.
Level 2 – switching to production to batch – disadvantages to Aaron Furniture
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Moving to batch might mean that Aaron Furniture Ltd have to invest in some
machinery. This will come at a cost, increasing their interest payments if they have
to borrow further money.
o Staff will need to be re-trained, this will take time and increase training
costs.
o Work may become boring for the more skilled staff, resulting in them
applying for other jobs and leaving the company. Skilled staff are difficult to
replace.
o If mistakes are made with a batch, the whole batch of wardrobes or bedside
tables are ruined. Using job production, only one product is ruined.
o Offering bespoke furniture might be Aaron Furniture’s USP. Losing this
might affect their competitive position resulting in less retailers stocking
their products.
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Analysis of data in Fig 3 – costs and selling
price data for Egerton bedroom furniture
range.
Total fixed cost apportioned to
the Egerton bedside table
Average variable cost
Average selling price
£12,000
£120
£180
Understanding the key terms
Fixed costs – these are costs that stay the same regardless of how much is being
produced. Fixed costs include:
• Rent for the factory (or some of the rent)
• Electricity
• Business and water rates
• Salaries (yearly) for some staff, such as managerial staff
• Marketing costs
Variable costs – these are the costs that are associated with each item being produced.
Therefore, they increase as production increases. In other words, the total cost varies
depending on production. Variable costs include:
• Wood used to manufacture the furniture
• Wages (hourly) of production staff
• Varnishing and any other wood treatments
• Packaging.
Level 1 – what is Break Even?
Break-even is a simple formula which
calculates how many products we need to
sell to cover all of our costs?
Revenue = the total costs (fixed + total
variable)
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Break-even is calculated by using the
following formula
Fixed Costs
(selling price – variable costs)
= no. of units needed to break even