2-48 CVP and Financial Statements for a Mega-Brand Company
Procter & Gamble Company is a Cincinnati-based company thatproduces household products under brand names such as Gillette,Bounty, Crest, Folgers, and Tide. The companyâs 2006 incomestatement
showed the following (in millions):
Net sales $68,222
Costs of products sold 33,125
Selling, general, and administrative expense 21,848
Operating income $13,249
Suppose that the cost of products sold is the only variable cost;selling, general, and administrative expenses are fixed withrespect to sales.
Assume that Procter & Gamble had a 10% increase in sales in2007 and that there was no change in costs except for increasesassociated with the higher volume of sales. Compute the predicted2007 operating income for Procter & Gamble and its percentageincrease.
Explain why the percentage increase in income differs from thepercentage increase in sales.
Procter & Gamble Company is a Cincinnati-based company thatproduces household products under brand names such as Gillette,Bounty, Crest, Folgers, and Tide. The companyâs 2006 incomestatement
showed the following (in millions):
Net sales $68,222
Costs of products sold 33,125
Selling, general, and administrative expense 21,848
Operating income $13,249
Suppose that the cost of products sold is the only variable cost;selling, general, and administrative expenses are fixed withrespect to sales.
Assume that Procter & Gamble had a 10% increase in sales in2007 and that there was no change in costs except for increasesassociated with the higher volume of sales. Compute the predicted2007 operating income for Procter & Gamble and its percentageincrease.
Explain why the percentage increase in income differs from thepercentage increase in sales.
Related questions
Question A
Cash BudgetProblem
The Teletron Corporationmanufactures different types of printers for personal computers.The company is planning its cash needs for the first quarter of2006. In the past, Teletron has had to borrow money during thefirst quarter since sales peak during this period of time. It wouldlike to be aware of any potential cash shortages before theyoccur.
The Controller asks you,the Senior Budgeting Accountant, to prepare a Cashbudget for January, February, and March 2006 for the entirecompany. Today is December 1, 2005 and you have just met with otheremployees from the Purchasing, Production, Marketing, and Financedepartments. From this meeting you compiled the following table ofinformation (all based on estimates).
2005 | 2005 | 2006 | 2006 | 2006 | |
Nov | Dec | Jan | Feb | Mar | |
Raw MaterialsPurchases | $ 20,000 | $ 25,000 | $ 25,000 | $ 20,000 | $ 25,000 |
Direct Labor Hours | 1,600 hrs | 1,760 hrs | 1,760 hrs | 2,240 hrs | 1,760 hrs |
Factory OverheadCosts | $ 4,000 | $ 4,000 | $ 4,000 | $ 4,000 | $ 4,000 |
Selling & AdministrativeExpenses | $ 10,000 | $ 12,000 | $ 12,000 | $ 10,000 | $ 12,000 |
Sales to customers | $ 100,000 | $ 110,000 | $ 120,000 | $ 110,000 | $ 100,000 |
Monthly sales to clientsare expected to be collected as follows: 60% in the first monthfollowing the sale; 30% in the second month following the sale; and10% in the third month following the sale. Note that October 2005sales to customers totaled $ 90,000.
Raw Material Purchasesare expected to be paid as follows: 50% in the month of thepurchase; 50% in the following month.
The production workersmake $ 25 per hour. There is no overtime and all wages are paid inthe month they are incurred.
Factory Overhead Costs arepaid in the month following the month they are incurred.
Selling &Administrative Expenses are paid in the month in the month they areincurred.
Teletron plans onborrowing $ 100,000 from its bank and will receive the money onJanuary 1, 2006. The loan is due to be paid back in 2008 in a lumpsum payment. The yearly interest rate will be 12% and interest willbe paid each month (assume the same interest expense each monthregardless of the number of days in each month).
Teletron plans on makingtwo $ 75,000 federal income tax payments during 2006 %u2013 one inJanuary 2006 and the other one in June 2006.
Teletron plans on paying$ 200,000 cash for the purchase of new production machinery inFebruary 2006.
Teletron plans on issuing(selling) 30,000 new shares of common stock in March 2006. Thesales price is expected to be $ 25 per share.
Teletron expects its cashbalance on December 31, 2005 to be $ 45,000.
(continued onback)
Requirements:
1. Prepare a cash budget for Teletron for each month of the firstquarter 2006 (i.e. January, February, and March 2006).
2. Comment on whether the ending cash balances each month areadequate for Teletron%u2019s cash needs and what Teletron might doin a month where the estimated cash balance isnegative.
QuestionB
Cost-Volume-ProfitAnalysis Problem
The Salazar Corporation manufactures only oneproduct %u2013 a medium-size, high-quality paper shredder calledthe MS-100. In an effort to better understand cost behavior,Salazar%u2019s accounting department has identified its costs aseither variable or fixed.
Salazar%u2019s Management wants to performCost-Volume-Profit (CVP) analysis to evaluate three differentscenarios it is considering for the year 2012. Under the currentproduction process (Scenario 1), variable costs are $ 90 per unitand fixed costs are $ 420,000 per year. The sales price for theMS-100 is $150 per unit and the number of units to be sold in 2012is 20,000 units.
Scenarios
- Leave the current production process as it is- make no changes.
- Purchase machinery that will decreasevariable costs by $ 30 per unit will but increase yearly fixedcosts by $ 390,000
- Purchase machinery that will decreasevariable costs by $ 15 per unit but will increase yearly fixedcosts by $ 255,000.
Requirements:
a) Calculate thecontribution margin per unit and the contribution margin ratio foreach of the three scenarios. Show your calculations.
b) Calculate the breakevenpoint in units and dollars - only for ScenarioI, the current production process. Show yourcalculations.
c) Prepare a contributionmargin income statement for each of the threescenarios.
d) Which of the three scenariosprovides the highest net income for the Salazar Company?
Salazar%u2019s management subsequently makes adecision that the company must make
$ 918,000 of after-tax net income in 2012,otherwise certain investors might decide to sell their ownershipinterest.
e) Calculate the salesthat Salazar must make in order to produce an after-tax net incomeof $ 918,000 (both in total sales dollars and in total salesunits). This calculation should be based on thescenario in d) that provides that highest net income.Salazar%u2019s income tax rate is 20%. Show your calculations.
f) Prepare aforecasted contribution margin income statement that shows theresults for the sales level computed in part e) above.
In the early 1990s, Cranston Dispensers, Inc. was quick torealize that concern for the environment would cause many consumerproduct manufacturers to move away from aerosol dispensers tomechanical alternatives that pose no threat to the ozone layer. Inthe following decades, most countries banned the most popularaerosol propellants, first chlorofluorocarbons and thenhydrocholrofluorocarbons. As the leading manufacturer ofspecialized pump and spray containers for a variety of products incosmetics, household cleaning supplies, and pharmaceuticalindustries, Cranston experienced a rapid increase in sales andprofitability after it made this strategic move. At that time, thefirm focused much of its attention on capturing market share andkeeping up with demand.
For most of 20x4 and 20x5, however, Cranstonâs share price wasfalling while shares of other companies in the industry wererising. At the end of fiscal 20x5, the company hired Susan McNultyas the new treasurer, with the expectation that she would diagnoseCranstonâs problems and improve the companyâs financial performancerelative to that of its competitors. She decided to begin the taskwith a thorough review of the companyâs working capital managementpractices.
While examining the companyâs financial statements, she notedthat Cranston had a higher percentage of current assets on itsbalance sheet than other companies in the packaging industry. Thehigh level of current assets caused the company to carry moreshort-term debt and to have higher interest expense than itscompetitors. It was also causing the company to lag behind itscompetitors on some key financial measures, such as return onassets and return on equity.
In an effort to improve Cranstonâs overall performance, Susanhas decided to conduct a comprehensive review of working capitalmanagement policies, including those related to the cash conversioncycle, credit policy, and inventory management. Cranstonâsfinancial statements for the three most recent yearsfollow.
Cranston Dispensers
Income Statement
($ in thousands)
Account | 20x5 | 20x4 | 20x3 |
Sales | 3,784 | 3,202 | 2,760 |
Cost of Goods Sold | 2,568 | 2,172 | 1,856 |
Gross Profit | 1,216 | 1,030 | 904 |
Selling & Administrative | 550 | 478 | 406 |
Depreciation | 247 | 230 | 200 |
Earnings Before Interest and Taxes | 419 | 322 | 298 |
Interest Expense | 20 | 25 | 14 |
Taxable Income | 399 | 297 | 284 |
Taxes | 120 | 89 | 85 |
Net Income | 279 | 208 | 199 |
Cranston Dispensers
Balance Sheet
($ in thousands)
Account | 20x5 | 20x4 | 20x3 |
Current Assets | |||
Cash | 341 | 276 | 236 |
Accounts Receivable | 722 | 642 | 320 |
Inventory | 595 | 512 | 388 |
Total Current Assets | 1,658 | 1,430 | 944 |
Net Fixed Assets | 1,822 | 1,691 | 1,572 |
Total Assets | 3,480 | 3,121 | 2,516 |
Current Liabilities | |||
Accounts Payable | 332 | 288 | 204 |
Accrued Expenses | 343 | 335 | 192 |
Short-term Notes | 503 | 491 | 243 |
Total Current Liabilities | 1,178 | 1,114 | 639 |
Long-term Debt | 398 | 324 | 289 |
Other Long-term Liabilities | 239 | 154 | 147 |
Total Liabilities | 1,815 | 1,592 | 1,075 |
Ownersâ Equity | |||
Common Equity | 1,665 | 1,529 | 1,441 |
Total Liabilities & Equity | 3,480 | 3,121 | 2,516 |
Question:
Suppose Cranston institutes a policy of granting a 1% discountfor payment within fifteen days with the full amount due in 45days. Half the customers take the discount, the other half take anaverage of sixty days to pay.
What is the length of Cranstonâs collection cycle under this newpolicy?
In dollars, how much would the policy have cost Cranston in20x5?
If this policy had been in effect during 20x5, by how many dayswould Cranston have shortened the cash conversion cycle?
