(Table 1)
The principal budget factors outlined in table 1 show that because of the limit on materials available to the business they could only produce within those limiting factors. Also the maximum demand for product A is 1000 and the maximum demand for product B is 1500. This means as well having a limit on the amount of materials available to the business, they will also have to keep the total production below these limits. This puts restrictions on the business from achieving maximum contribution from both the products they produce. As they may not be able to produce the maximum demand, because of the lack of materials the business can purchase in the coming year. This will mean the business has to consider an optimum production budget, which gives the maximum contribution available from the limiting factors that the business faces.
Production Budget
The most accurate way of calculating the production budget that will maximise the contribution for the business is through linear programming. “Linear programming is a mathematical technique that an be applied to the problem of rationing limited facilities among many alternative uses in such a way that the optimum benefits can be derived. It seeks to find a feasible combination of output that will maximise or minimise the objective function.” (Drury, 2000, p1031). In this case the objective function will be contribution per unit and the problem is how to maximise the contribution. Linear programming can be performed either by implementing a graphical method, which only applies if there are two products, or by using solver software in Microsoft Excel, which can be used for multiple products.
To achieve the most accurate results for this report both methods of linear programming will be used to find a feasible solution for the objective function.
By using the graphical method the five constraints are plotted so that a solution point can be located. (All workings that have been used to plot the constraints can be found in the appendix under Calculations). The solution point will satisfy the objective function. Figure 1 (see appendix) demonstrates the above graphical method. From fig. 1 it can be seen that the solution point is the corner of the feasible region furthest to the right. This is the point at which constraints A and B intercept. From this point the number of units of product A and B can be read from the axes. These values will present the optimum production plan and thereby maximise contribution. From fig 1 the optimum solution is 1000 units of product A and 500 units of product B. The maximum contribution can be calculated by:
= Units of A (contribution) + units of B (contribution)
= 1000(10) + 500 (12)
= 10,000 + 6000
= £16,000
To verify this result the second method of using solver is used to calculate the units of products A and B to enable maximum contribution whilst satisfying the constraints. The model sheet (see appendix) shows the optimum solution to be 1000 units of product A and 500 units of product B therefore producing a maximum contribution of £16,000. This confirms the solution produced by the graphical method. (Data and model sheets from Excel can be found in appendix)
Recommendations
In order to increase the potential contribution in the long term the business needs to focus on several aspects, ranging from internal and external influences. The most important internal aspect that the business can focus on is trying to reduce the variable cost per unit of output, this can range from bringing in more advanced machinery, which will cut the labour cost in production and produce each unit at a faster rate. This will increase the contribution even if the selling price remains unchanged.
The external factors which the business should focus on to increase contribution in the long term are; finding cheaper suppliers for materials used, which will decease the variable cost per unit of output. Try to reach a bigger market group to increase maximum demand for each product this will help achieve higher sales figures which will in turn increase the contribution. By observing these internal and external aspects it is important to look to the future to set strategies and targets that the business is likely to achieve. Some types of strategies that maybe considered are; possibilities of introducing of new products that will help reach a new and wider market area. This process is called diversification and when implemented correctly can generate a substantial contribution. Also new markets may be reached by giving products a facelift and changing the image.
Other areas that need to be considered are the strengths and weaknesses of the business. So it can concentrate on the areas that are performing well and identify areas that need to be improved so that the business can continue to grow. Also it is important to observe the competition and see which products are they producing and their selling price, this will help set future prices to remain competitive in the market.
Bibliography
Bierman H, Dyckman R. T, (1976). Managerial Cost Accounting, 2nd edition, USA, Macmillan Publishing Co.
Drury C, (2000), Management & Cost Accounting, 5th edition, London, Thompson Learning.
Lucey T, (1996), Management Accounting, 4th edition, Letts Educational.
McLaney E, Atrill P, Accounting an introduction, 2nd edition, Essex, Pearson Education Ltd.
