Presentation on theme: "Production and Inventory Management"— Presentation transcript:
1 Production and Inventory Management Chapter 11Production and Inventory Management
2 Why It Is Important to Understand the Cost Relationships in Production and Inventory Management They affect the economic efficiency (profits) of the firm.An understanding of these relationships helps managers make more effective production decisions.As a result, managers are better able to meet their financial objectives
3 Management Information Systems MIS providesAccurate and timely production and cost information on all phases of the businessData in the proper form needed for decision makingAccounting information that will allow fast, accurate development of business financial documentsA means for efficiently and effectively monitoring and controlling business production costs
4 Cost Concepts Cost: what is given up to acquire a good or service Opportunity cost: the return (as measured by the highest value) that is given up in a foregone useImplicit cost: costs that do not include cash payments but need to be included in the calculation of the total cost of product
5 Cost Concepts Controllable and Uncontrollable Costs Incremental, Avoidable, and Sunk CostsTotal Cost = Total Fixed Cost + Total Variable CostsTotal Fixed Cost (TFC)Total Variable Cost (TVC)Total Cost (TC)
7 The Contribution Concept Contribution equals selling price/unit minus variable cost/unitThe contribution per unit is used first to pay fixed costs and later profitsSelling Price/Unit = Total Cost/Unit + Profit/UnitTotal Cost/Unit = Variable Cost/Unit + Fixed Cost/UnitSelling Price/Unit – Variable Cost/Unit = Fixed Cost/Unit + Profit/Unit
8 Using the Contribution Concept to Establish the Selling Price of a New Product If the contribution/unit is 40% of the selling price/unit, the selling price/unit would be:TotalVariable CostsPer Unit=[1 – Contribution MarginPercentage]×[Selling PricePer Unit]For example,$ = [1 – 0.40] × Selling Price/ Bag$1200.60= Selling Price per Bag$ = Selling Price per Bag
9 The Shutdown Point Short-term versus Long-term Pricing In the short term, a firm with idle capacity can take a job where the price does not cover all the total cost as long as the contribution is positive (P – AVC > 0).If the contribution is negative (P – AVC < 0) the firm is better off shutting down.Over the long term, all costs must be covered.
10 Break-Even AnalysisBreak-even analysis helps managers find the combination of costs, output, and selling price that permits the firm to break even, with no profits and lossesSelling PriceOutputCosts
11 Calculating the Break-Even Point in Units The break-even point is calculated from the profit equation when profit is zero.Profit = 0 = Total Revenue – Total Cost0 = Total Revenue – TVC/Unit – TFC0= P × Y – VC × Y – TFC= (P – VC) Y – TFCTFC = (P – VC) YTFC(P – VC)Y == Break-Even Point in Units
12 Calculating the Break-Even Point in Dollars TFCBEP$ =CMPWhere: BEP$= Break-Even Point in DollarsTFC = Total Fixed CostsCMP = Contribution Margin PercentageFor example,BEP$ =$750,0000.40BEP$ = $1,875,000 = The Break-Even Point in Dollars
13 Meeting a Profit as a Percentage of Sales Objective Using Break-Even Analysis TFC(CMP – RPP)BEP$ =RPP = Required Profit PercentageFor example,BEP$ =(0.40 – 0.10)$750,000= $2,500,000(or 20,000 bags at $125 per bag)
14 Evaluating Changes in Fixed Costs Using Break-Even Analysis Minimum Changein Dollar Sales Neededto Break Even for theChange in Fixed CostsChange in Fixed Costs=Contribution Margin PercentageFor example,$1.00= $2.50 = the minimum increase in dollar salesneeded to break even for each new dollarspent on fixed costs0.40
15 Determining a Selling Price Using Break-Even Analysis Selling Price/Unit = Contribution + Variable Cost/UnitIf Variable Cost/Unit is known, all that is needed is ContributionContribution can be determined by rearranging the termsof the break-even equationTFC= YContributionTFCY= Contribution
16 Inventory Management Reasons to hold inventory Matching supply with demandPrevent stockoutsLower purchasing costsReasons not to hold inventoryHigh maintenance costHigh protection costDepreciation and obsolescenceTaxes
17 Impact of Inventory on Profits Value of Inventory = $100,000Inventory Carrying Cost = $25,000 (25 percent)Each $1,000 reductionin Inventory = $250 Profitsin Inventory = $5,000 in SalesWhy It Pays to Keep Inventories Low!
18 The Basic Inventory Management Model The total cost of inventory (TC) equals the sum of ordering costs (OC) and carrying costs (CC)TC = CC + OCManagers’ goal is to minimize total cost. A manager needs to determine:Economic Order Quantity (EOQ): the number of items to buy in each order that will minimize total cost, andReorder Point (ROP): when to reorder to minimize the chances of stockouts
20 Discussion QuestionsExplain why an agribusiness manager needs to understand production and inventory management. Give two examples of situations in which cost management made a difference.Describe the relationship between the firm’s accounting system and its management information system. Give a definition for each. Explain which one is most important to management.What is opportunity cost? Is it relevant to business decision making? Explain your answer. Give an example that shows its impact.Describe the relationship between implicit and explicit costs. Describe how they are measured. Explain their role in production and pricing decisions in an agribusiness. Describe, using an example, how failure to properly account for them can get an agribusiness into trouble.
21 Explain how agribusiness managers use avoidable and sunk costs in their decision making. Why is this decision-making process called incremental analysis? Define economic efficiency and show with an example how incremental analysis helps firms increase their economic efficiency.Draw a simple graph showing the total cost, fixed costs, and variable costs as production increases. Explain why each line looks the way it does.Define the term “contribution” as used in this chapter. Give an example of how it could be used to price a new product.
22 Explain why a firm would take a job that does not give it a chance to make a profit. Explain when it would not accept this opportunity. Use a numerical example to explain why it is important for managers to know the difference between the two.Using the break-even equations, describe and explain the relationship between cost, selling price, and output. Use a numerical example to make your points.Describe and explain the importance of good inventory management of the firm’s overall objective of maximizing its long-term profits. What is the role of supply chain management and information technology in this process? Use a numerical example to make your points