Importance of costs in pricing strategy of NML

Describe about the Managing Finance Principles and Techniques of NML?

Costs are important in pricing system as it provide NML to assess the price of the different products at overall profit or making profit separately. As stated by Berry and Jarvis (2005), costing method in NML is different comparing to others. Company used least square method of costing technique as there are three different products in its portfolio. Therefore, company has to deal with many mixed cost that are hidden in production of three products (Drury, 2009). In this context, NML is using the cost based pricing staretgy where all the costs are segregated into variable cost and fixed cost, thus introducing the cost based on flexible activity in operation (Glynn etal. 2003).   

Total Cost	7000	8000 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	9000
Units	200	300	400
Break Even	35	26.66667	22.5
Selling price (if Profit = 20%)	42	32	27

It can be analysed that by applying the cost based pricing, the selling price shows different value for different cost units. In order to gain a profit of 20%, the company might have to fix selling price of 42 for each product in order to cover the total cost of 7000. Therefore, it is similar for other costs.

A costing system may be designed on basis of activities in the operation. The system is widely used in production as it provides the company opportunity of defining its costing method according to the activities (Harris and Sollis, 2003).

The limitation that is associated with the existing costing system is that it may limit the ability of the company to price their product in different market segments. On the other hand, unrealized profit or revenue would be substantial. Moreover, the future demand for any particular product may not be accounted under this method.

Activities	Level of output	Cost in £	Total Cost in £
Activity 1	200	****
Activity 2	300	****
Activity 3	400	****
Activity 4	500	****	****

Table 1: format for activity-based costing

The system adapted by NML might be improved if it is changed into an activity based costing. Due to presence of costing details of every activity of different levels, it would be easier for the managers to control the cost of overall production (de Jong et al. 2013). By employing ABC method, the company would be receiving reliable and accurate results regarding costs. Moreover, the overheads that comprise variable costs and fixed costs can be controlled by effective monitoring and controlling of activities. Therefore, effective decision can be made by the firm relating to product lines profitability.

Form the point of view of costing system, it is recommended that company must follow a controlling system so that cost can be controlled in many stages and thus increasing the operating margin. In order to improve the existing costing system, the company can adopt policy of competition based pricing. It will help the company in finalizing the product price after careful analysis of prices fixed by competitors. Once the product costs are calculated then the company can fix the price of their each product. Therefore, weakness of cost based pricing of the company can be overcome by adopting competition based pricing.

As stated in the problem, the forecasted increase in some financial matters has changed the financial statement of company. Due to change in sales and cost of sales, the increase in operating profit has gone up by 24.66%. Unchanged interest cost in coming year provides the company to post a better PAT in 2015 as estimated. According to Lin (2012), cost can be reduced by controlling the interest cost of borrowings. Further, rising in net working capital as projected, shows the way of reducing the cost of short-term loan. 

	2014	2015E
turnover	300	330
cost of sales (deducting depreciation)	164	180.4
operating profit	120	149.6	24.66667
interest cost	30	30
pretax profit	90	119.6
corporation tax	24	28
profit after tax	66	91.6
proposed dividend	44	48.4
retained earnings	26	43.2

Design of a costing system and proposed improvements in costing and pricing system

Table 2: forecasting of revenue and cost

The forecasting techniques that can be used by the company are moving averages and time series analysis. By using moving averages, the company would be successful to smooth the financial data and it will be easy for the company to spot trend. As a result of that, they would be known whether they will be making profit or loss in future. On the other hand, time series analysis can be effective in forecasting the revenue and costs in future by studying the historical data of the company. Therefore, on the basis of forecast, the company can make effective decision for their business.

Retained earnings: The Company can finance their expansion program by using their retained earnings. It is seen that in 2014, the company has a retained earnings of £26 million in 2014. Therefore, it can be used and by using it company may not be paying any interest to others.

Banks: The financial institution can be other source to gain funds. The company can borrow money as per their requirement. However, the company has to deposit any assets as a security. On the other hand, the company can also go overdraft in order to fund their expansion program.

The budgetary targets that have been selected for each of the products that are PS and TG of NML are variable costs, fixed costs and sales production. Through sales production, the company will know how much production has been made in next year in comparison to last year. Similarly, variable and fixed costs can also be studied to know much costs have incurred for each of the product. Budgetary sales unit for PS is 5000 units while opening inventory of that product is 100 units. Further, closing inventory of PS is 1100 units. Therefore, estimated units to be produced are (5000-100+1100) = 6000 units for PS in the certain period.

The following table shows the master budget of company:

	PS	TG
Budgeted Sales	5000	1000
Required Closing Inventory	1100	50
Opening Inventory	100	50
Budgeted Production In Units	6000	1000
Selling Price	95	130
Sales Revenue	570000	130000
Variable Cost	75	85
Total Variable Cost	450000	85000
Total Fixed Cost	35000	15000
Net Income	85000	30000

Table 3: Production and sales budget

It can be discussed that, the PS product will generate an income of £85000 with a total cost of £485000. Moreover, it is seen that the selling price is low in comparison to selling price of product TG. Therefore, the income that would be generated from product TG is £30000. However, it can also be noticed that, production unit of TG is less than PS due to that income and cost is less.

	Actual	Budgeted Income	Variance
Sales	4000	5000	1000
Selling Price	96	95	-1
Production	6500	6000	-500
Sales Revenue	624000	570000	-54000
Total Cost	485000	485000	0
Income	139000	85000	-54000

Actual and estimated income of PS

	Actual	Budgeted Income	Variance
Sales	900	1000	100
Selling Price	125	130	5
Production	950	1000	50
Sales Revenue	118750	130000	11250
Total Cost	100000	100000	0
Income	18750	30000	11250

It is seen that company has generated an income of £54000 more as per the prepared budgeted income. Therefore, product PS  provided a better value to the company. The company has increased the selling price by 1 unit due to increase in the total cost. As a result, the £130000 income has been generated from the sale of PS.

On the other hand, the company has witnessed a loss of £11250 from the sale of TG. The reason is decline in the sales value and production. Moreover, there is no decline in the value of total cost due to that there is significant loss of income.

Recommendations of proposals for improving the existing system

As stated by Burger and Hawkesworth (2013), preparing a budget does not make any sense as management needs to control all financial aspects as per the budget produced at the starting of the year. Therefore, monitoring of budget is an exceptional tool in this segment as it provides the management to have control over the various activities of operation. In order to monitor the budget of the company, the management has counted on variance analysis. Both favourable variances and adverse variances are known by the management. Therefore, it helps in identifying possible gap in actual figures and budgeted figures. It is true that systematic observation provides control over the deviation from the estimated figure. Moreover, financial experts are hired for monitoring budget (cipfa.org.uk, 2015).

From the given problem, NML may apply the process of reduction of holding inventory for lesser days as it will reduce the cost of materials in revenue account. In order to have a better control over the cost, the management can count on Total Quality Management. It will help in increasing the productivity of the company through effective management of costs. Therefore, the company can witness quality production with minimum utilization of cost.

Value Analysis can be other recommendation which will be helpful in enhancing the work effectiveness. Through this, the management can identify extra or unnecessary costs that are bear by the company. As a result, the company will receive quality and better production.

The activity-based costing may be used in NML in evaluating the costing of the company. It provides the means of controlling the cost of every activity mainly for a longer period of production (aat.co.uk, 2015). Through employing ABC method, activities that are related with the production process can be effectively identified. Moreover, each costs can be also be identified such as direct material, direct labour, overhead costs, etc that usually not considered. On the other hand, the cost driver can also be calculated by using ABC method such as machine hours, testing hours, labour cost, etc.

Financial appraisal methods for the projects and justified decision

The appraisal method of selecting the project is normally considered as the quantitative approach of assessing the future of investment so that risk associated with the investment becomes low. This is the main strategy applied by the investors in a long-term perspective (Bized.co.uk, 2015). As stated by White et al. (2003), different techniques of assessments are applicable for different objectives of the investment and on project basis.

In this context, net present value (NPV) method is applied for evaluating the investment decision between two projects – A and B. The NPV estimation of project A provides that investment will yield £207357.24 after five years of investment and at the same for the project B will be £309806.15. Therefore, from the first look any investor will go for the project B, while it is true that the sum invested in this project is more than that of the project A. Thus, another method is necessary where irrespective of sum of the invested sum; only on basis of period of investment the rate of return might be calculated. Thereby, no decision can be made from this technique of appraisal.

option A
Year	cash flow	NPV
0	-400000	$207,357.24
1	100000
2	140000
3	180000
4	210000
5	230000
option B
Year	cash flow	NPV
0	-950000	$309,806.15
1	250000
2	300000
3	350000
4	400000
5	450000

Forecasting techniques for revenue and cost

Table 5: Investment appraisal using NPV methods

option A
Year	cash flow	NPV	IRR	ARR
0	-400000	$207,357.24	27%	outflow	40000
1	100000			return from investment	860000
2	140000			rate of return	20.5
3	180000
4	210000
5	230000
option B
Year	cash flow	NPV	IRR	ARR
0	-950000	$309,806.15	22%	outflow	95000
1	250000			return from investment	1750000
2	300000			rate of return	17.42105
3	350000
4	400000
5	450000

Table 6: Investment appraisal using IRR and ARR method

From the above table, it might be observed that project A and B are appraised using the IRR and ARR method where both methods state that investors must go for the project A as the project B yields low rate of return within the period. Project A has tested better result from the both method so decision can be taken for making investment for this project. Further, it is recommended that project A is better looking in terms of assessing techniques still now so company must go for it.

Investment decision making is important approach for any business to enhance their business and acknowledge growth. It is observed that only quantitative method of appraising is considered while the risk associated with the projects are not being assessed. Therefore, without knowing the facts on the qualitative information of the project risk associated cannot be evaluated.

Further, the macroeconomic changes and risk associated with economic factors are always a concern for making the investment decision (Askarany et al. 2012). In this context, it is observed that two projects are not of same type therefore, macroeconomic risks associated with those are not same.

Further, business risk is a main factor in assessing the project’s investment decision so that company might be able to make decision on investment. Strategically it may be said that company might select the project B as it provides the company to invest more money providing more utility of unused investment fund whereas in project A, the total sum of investment is low thereby; it cannot fully utilized the investment fund (companies-house.gov.uk, 2015).

Analysis of financial statements

As per the variance analysis between two financial year data of the NML group which is certain growth in the revenue turnover of the company is around 3.45% and because of the huge number of dividends proposed by the company retained earnings on the company is showing negative figures in the statement of variance analysis of the company. The company is able is acquired 0.71% net assets increment in the financial year 2014 whereas the reserve of the company is showing growth of the 1.10% in the year 2014 respectively. According to the overall variance analysis of the company the company is showing stable situation which is in growth than the financial year 2013.

According to the ratio analysis of the company NML is measured to understand the actual position of the organization in the market. The current ratio of the company is mainly depends on the measurement of the earning capacity of the company which is 1.707 and 1.709 in the year 2014 and 2013. The gross profit margin of the company is also shows the percentage of the 30% and 28.44% in the year 2014 and 2013 and also the net profit margin of the NML group is 22% and 20.87% respectively. The inventory turnover of the company NML is showing ratio of the 2.5 and the 2.9 in the financial year 2014 and 2013. The return on equity ratio which is coming 0.33 and 0.30 which is company gaining from the investment of the owned capital in the company’s operational activities.

As per the financial details provided by the company in a particular financial year which is 2013 and 2014; It is showing that company is more focusing in the proposing dividends for the company which is good for the portfolio of the company in front of the investors who are willing to invest their money in the shares of the company because of the higher dividend earnings ratio. The company NML group is not able to retained the earnings for the financial year 2014 but company will be grow in the coming financial because of the huge investment finance from the investors who attracts because of the proposed dividend of the company.

Reference lists

Berry A and Jarvis R – Accounting in a Business Context, (2005) (Cengage Learning EMEA) ISBN 1844802515

Drury C – Management Accounting for Business, (2009) (Cengage Learning EMEA) ISBN 1408017717

Glynn J, Perrin J, Murphy M and Abraham A (2003)  – Accounting for Managers, 3rd Edition (Thomson Learning) ISBN 186152904X

Harris R and Sollis R (2003) – Applied Time Series Modelling and Forecasting (John Wiley and Sons) ISBN 0470844434

White G I, Sondhi A C and Fried D (2003) – The Analysis and Use of Financial Statements, 3rd Edition (John Wiley and Sons) ISBN 0471375942

de Jong, M., van Beek, I. and Posthumus, R. (2013). Introducing accountable budgeting. OECD Journal on Budgeting, 12(3), pp.1-34.

Lin, W. (2012). Financial performance and customer service: An examination using activity-based costing of 38 international airlines. Journal of Air Transport Management, 19, pp.13-15.

Burger, P. and Hawkesworth, I. (2013). Capital budgeting and procurement practices. OECD Journal on Budgeting, 13(1), pp.57-104.

Askarany, D., Brierley, J. and Yazdifar, H. (2012). The effect of innovation characteristics on activity-based costing adoption. International Journal of Managerial and Financial Accounting, 4(3), p.291.

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companies-house.gov.uk, (2015).   Available from: https://www.companies-house.gov.uk [Accessed on: 11 Apr. 2015].